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Moody's: China banking system outlook stable, but high economy-wide leverage slow to reduce

27 Sep 2018

Hong Kong, September 27, 2018 -- Moody's Investors Service says outlook for the Chinese banking system
is stable over the next 12-18 months.

"Our stable outlook reflects the fact that two factors — the
rising trade tensions between the US and China, and indications
that deleveraging and de-risking are starting to weigh on investment
— have shifted the Chinese authorities' focus toward more accommodative
policy, balancing its efforts between promoting deleveraging and
sustaining growth," says Yulia Wan, a Moody's
Assistant Vice President and Analyst.

"This situation will result in an operating environment over the
next 12-18 months that is broadly supportive of bank credit quality
and stable asset quality," adds Wan. "However,
it also suggests that the country's exposure to high economy-wide
leverage will be slow to reduce."

In addition, Moody's has also released a podcast that discusses
some of the key points of its outlook for the banking system: http://wwww.moodys.com/chinabso

The stable outlook is based on Moody's assessment of six drivers:
operating environment (stable); asset quality (stable); capital
(stable); profitability and efficiency (stable); funding and
liquidity (stable); and government support (stable).

On the operating environment in particular, Moody's says that
its stable assessment takes into account the continued economic growth
in China, which benefits from more accommodative policies and a
gradual change of the economic structure to higher value-added
sectors.

Moody's baseline scenario assumes a GDP growth for the country of
around 6.0%-6.5% in the next few years.
This situation, together with the return of some shadow banking
activities to the banks' balance sheets, should support the banks'
steady loan growth.

With asset quality, Moody's says the banks should show stable
asset quality, but also elevated risk associated with weak borrowers.

In particular, loan delinquencies will stabilize, because
of steady economic growth and improved corporate financials. Nevertheless,
corporate leverage remains high and asset risk is elevated for some highly
leveraged and loss-making borrowers.

Asset transparency will improve because of tighter regulations to recognize
problem loans and to curb the banks' use of pass-through channels
for lending.

As for capitalization, Moody's says that the banks'
capitalization levels will stay broadly stable and adequate, underpinned
by their ability to generate internal capital, steady asset growth
and robust capital-raising pipelines. Risk-weighted
assets will continue to grow faster than total assets, as the banks
shift their asset mix to loans from previous investment in shadow banking
products.

Funding and liquidity conditions will stabilize, on a more accommodative
policy stance, such as cuts of the required reserve ratio and increasingly
extensive use of medium-term lending facilities. But smaller
banks still face liquidity management challenges from rising deposit competition
and the broad shift in their assets back to loans.

Profitability will stabilize, but key profit metrics will remain
subdued. Specifically, net interest margins will stabilize,
because strong demand for formal financing will support loan pricing;
although banks that lack a strong deposit base will face higher competition
for deposits.

Non-interest income growth will be pressured by a slowdown in the
shadow banking sector and rules to abolish or suspend certain fees.
And, credit costs will remain high to reflect high corporate leverage.

On the issue of government support, Moody's expects such support
to remain strong for major banks, reflecting the policy imperative
to maintain public confidence and systemic stability.

Moody's rates 27 banks in China. Together, they accounted
for 69% of total system assets at the end of 2017. Of the
27, 24 are commercial banks, with an asset-weighted
average Baseline Credit Assessment (BCA) of baa2 and long-term
deposit rating of A2.

The report may also be found through Moody's topic page "China's trade-off:
Deleveraging and stability", available at http://www.moodys.com/chinarebalancing.
This page provides a centralized source for Moody's research related to
key credit issues in China as the country's macroeconomic story continues
to unfold.

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